Anyone who’s been fishing knows that
one of the keys to catching the big one is having the right
kind of bait. Many in the financial services industry
understand this truth all to well and they’ve come up with
the perfect enticement to hook unsuspecting investors. It’s
called the equity-indexed annuity (EIA) and chances are, if
you’ve visited a traditional advisor recently, you’ve heard
its compelling pitch.
Of course, for bait to be effective, it has to be something
the intended target will happily swallow. Insurance
companies have created a wonderful presentation that uses
smoke and mirrors to give investors the impression that
equity-indexed annuities are the answer to all their
financial problems. But the reality doesn’t live up to the
promises.
The marketers of financial products know that one thing
older investors want is simplicity. Seniors don’t want to
have to wade through a lengthy sales pitch or be overwhelmed
by financial techno-babble. Salespeople know if they can
offer an apparently simple solution to investors, their
chances of making the sale are greatly increased.
Equity-indexed annuities are presented as being a simple way
to have risk-free growth of your nest egg. They promise a
guaranteed minimum return, while keeping the growth
potential of the market. They promise that you can’t lose
any money and many even sweeten the pot with first year
bonuses and riders that allow you to access your money for
nursing home care and other early withdrawals. It all sounds
so good and it’s so simple. But is it, really?
The answer is no. Equity-indexed annuities are actually very
complicated.
Let’s take a closer look at how complicated equity-indexed
annuities really are by starting with their chief claim, the
guaranteed minimum return. Most investors have the
impression that on a year-to-year basis they receive the
guaranteed minimum return or the market return, whichever is
higher.
But that’s not true. You either get the indexed return or
guaranteed minimum return for the life of the contract,
whichever is greater. So if it’s a 15 year contract, at the
end of the 15 years, the insurance company looks back and
figures whether you’d have earned more, at the guaranteed
rate or the market return for the entire 15 years. So
suddenly the guaranteed minimum isn’t too impressive.
To make matters more confusing, on some contracts you don’t
get the guaranteed minimum return on all of the money you
put in. For instance, some pay a 3% guaranteed minimum
return on just 80% of your initial investment. So in
essence, you’re really guaranteed only 2.4%. That doesn’t
sound as good, does it? When the list average on a short
term Certificate of Deposit is around 5%, why would you want
to lock in a 2.4% rate for 15 years?
How the index return is calculated is much more complicated.
You’d think that the insurance company would just tie your
market return to an established index, like the S&P 500, and
mirror its return. Unfortunately, it’s not that simple.
There are over 40 different methods in which these rates are
determined and they vary widely from company to company. The
explanations for these calculations are so complex, there’s
no way the average consumer could even hope to understand
them. Even professionals find these methods extremely
confusing.
Even if you could understand how your index return is
calculated, it doesn’t matter because the insurance
companies can change how they calculate it from year to
year. They can also modify the maximums, minimums,
participation rates, asset fees, other charges at their own
discretion. And there’s nothing you can do about it.
Why would insurance companies do this? That part is very
simple. Insurance companies understand the importance of
keeping their flexibility and control, because they
know that the markets and interest rate environments can
change dramatically over the life of your contract. They put
these safety valves in place so they make sure
they make a profit. Of course, that can reduce how much
you make.
If insurance companies put a high priority on maintaining
their flexibility and control, shouldn’t you? Be smart
and don’t take the bait purveyors of equity-indexed
annuities are offering. Use your head and don’t get sucked
into a deal that, like many others, you may soon live to
regret.
Mr. Voudrie is a Certified Financial Planner, nationally
syndicated newspaper columnist and President of Legacy
Planning Group, Inc., a Private Wealth Management Firm in
Johnson City, TN. He can be reached toll-free at
1-877-827-1463 or at
jeff@guardingyourwealth.com. |
|
